So Solar Is Hot Right Now, but What Are My Options?

January 2, 2024
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Readers of a certain age will remember the popular, “You’ve come a long way baby,” slogan from Virginia Slims. While that slogan no longer applies to the cigarette industry, it perfectly captures the state of Pennsylvania’s solar industry. As a result of various state and federal policy initiatives, solar energy is more readily available in Pennsylvania than ever before. However, understanding the opportunities available for municipalities and municipal authorities (municipal organizations) can be a daunting task. This article will briefly recap the policy developments driving Pennsylvania’s growing solar market and review popular models for solar projects available to interested municipal organizations.

Policy Background

In 2004, the Pennsylvania General Assembly passed the Alternative Energy Portfolio Standards Act (AEPS Act), which was intended to help galvanize construction of alternative energy resources, including solar development, by requiring electric distribution companies (the local electric company that owns and operates the physical electric poles and wires in your area) and electric generation suppliers (the various companies that sell electric power to be delivered to your home or business) to purchase a percentage of their energy supply from renewable energy sources.

Despite the AEPS Act, solar development in Pennsylvania grew at a slow pace during the early 2000s. The rate of development changed, however, in 2017, when the General Assembly amended the AEPS Act to limit (with some exceptions) qualifying solar energy resources to those that directly deliver electricity to customers or electric distribution systems from sources located in the commonwealth. This amendment catalyzed the market. For example, Pennsylvania’s total statewide installed solar capacity increased by only 200 MW from 2010 to 2017, according to the Department of Environmental Protection’s Solar Energy Resource Hub.

After the 2017 AEPS amendment, however, Pennsylvania experienced an increase in total installed solar capacity from approximately 250 MW in 2017 to 1,195 MW as of 2022.

More recently, the passage of the Federal Inflation Reduction Act (IRA) in 2022 offered further incentives for renewable energy projects, including solar projects. Most importantly for municipal organizations, the IRA includes direct pay benefits that allow tax-exempt entities to receive “tax credits” in the form of direct transfers from the IRS. This program can greatly help municipalities reduce the cost of solar projects.

The above state and federal policy initiatives, combined with continually decreasing production costs for photovoltaic cells, create promising opportunities for municipal organizations interested in solar projects.

Types of Solar Transactions

Before exploring a solar project with any vendor, municipal officials may find it helpful to have some working knowledge of the various types of solar project options, as well as the respective costs and benefits for each approach. The available options may evolve as legislators continue to deliberate further amendments to the AEPS Act, but currently, the following three models are common in Pennsylvania.

Directly Owned Renewable Self-Supply

Perhaps the least complex method for a municipal organization to install solar generation is to install the solar generation resource on its property, take ownership of the resource, and use the power to meet its electricity needs.

This model minimizes contractual dealings with third parties, other than perhaps a service contract for maintenance of the solar generation resource. The municipal organization may also be able to take advantage of net metering opportunities, through which the local electric distribution company will offset the kWh produced by the municipal organization solar generation resource against its consumption. If net metering is available, the municipal organization is additionally compensated for any excess production from the solar generation resource, provided the system does not exceed a nameplate capacity of 3 MW or in limited cases 5 MW. (For a complete explanation of the net metering rules, including the nameplate capacity cap and the definition of a “customer-generator,” please reference the guidance published by the Pennsylvania PUC.

The principal downside of the direct-ownership model is that the municipal organization bears the upfront costs for installation of the solar generation resource, which even while accounting for the available IRA tax credits, can still be substantial.

Virtual Power Purchase Agreement

Virtual power purchase agreement (VPPAs) are a powerful, but often misunderstood tool for structuring solar projects. VPPAs can be confused with another solar concept called virtual net metering. The difference is that virtual net metering relates to the physical location of the renewable energy resource. VPPAs have nothing to do with the physical location of the solar generation resource. They are virtual in the sense that they do not provide for any physical delivery of energy. Rather, a VPPA is a financial hedge tied to the future sales of energy generated by a renewable project. VPPAs can provide financial and marketing benefits, but an entity entering into a VPPA must still procure its actual energy through another resource.

Generally, the VPPA exchanges a fixed-price cash flow for a variable-priced cash flow and alternative energy credits. Under a VPPA, the buyer agrees to pay the solar developer a “strike price” for the energy produced by the solar generation resource, which is sold into the wholesale grid. The buyer than receives both the upside reward (receiving payment for the difference if the strike price exceeds the market price) and downside risk (paying the difference if the market price exceeds the strike price) of the price hedge. The buyer may also receive the alternative energy credits, which allow the buyer to market the transaction as a clean energy procurement, even though it did not take physical delivery of the energy from the project.

VPPAs can be a useful tool for certain buyers, but the administrative and regulatory resources required to manage a VPPA may be overly burdensome for many municipal organizations. For example, VPPAs often require more detailed review of monthly billing to confirm payment prices, as well as coordinating the sale or transfer of any alternative energy credits.

Standard Power Purchase Agreement with Independent Power Producer

Unlike a VPPA, a standard power purchase agreement (PPA) includes physical delivery of energy from the solar generation resource owned and operated by the independent power producer, typically for a fixed per-kWh price. The fixed price will generally include the energy as well as the alternative energy credits. These agreements can be structured for on-site or off-site solar generation resources, although PPAs for off-site generation projects may require separate market coordination agreements with an electric generation supplier to facilitate delivery of the energy and depending upon location and size may limit the ability to net meter.

A PPA with an independent power producer offers a convenient balance of flexibility and administrative simplicity. Because the independent power producer would own the solar generation resource, the municipal organization avoids upfront construction costs associated with direct ownership of the solar generation resource. The municipal organization also benefits from predictable fixed price power costs for the duration of the PPA and, depending on the size and location of the solar generation resource, may have net metering opportunities as well.

Regardless of the type of project your municipal organization may explore, consider working with specialized legal counsel to advise on regulatory matters and review key transactional documents, including vendor service contracts, VPPAs and PPAs. Solar installations are complicated long-term investments and the economic risks may hinge on terms and conditions unique to solar transactions. Moreover, these agreements often include terms and conditions touching several areas of law, including energy, insurance, real estate and environmental. Early engagement of legal counsel can minimize downstream contractual disputes and help develop a project contoured to the specific interests and goals of your municipal organization.

Timothy Horstmann is a public finance and tax attorney at McNees Wallace & Nurick, serving clients from Harrisburg. He has spent his entire legal career advising clients in matters related to state, local and federal taxation. He can be reached at thorstmann@mcneeslaw.com or 717-237-5462.

Ade Bakare is a water law and energy attorney at the firm, serving clients from Harrisburg and York. He serves as trusted counsel to several municipalities and municipal authorities, having worked closely with city managers, councils and mayors, as well as borough and municipal authority officials. He can be reached at abakare@mcneeslaw.com or 717-237-5290.